Cost plus pricing: the method that needs your numbers to be right

Cost plus pricing works out what something costs you and adds a margin. It is the default in trades, manufacturing, and most service businesses that quote per job, and it has two real virtues: the price is defensible to a customer, and it is almost impossible to sell below cost by accident — provided the cost figure is right.

That proviso is where the method fails. Companies that price cost-plus using direct costs only, ignoring overhead and their own time, are applying a healthy-looking margin to a figure that is not the cost. The margin then absorbs everything that was left out, and the business is busy and unprofitable at the same time.

What belongs in the cost

• Direct materials or bought-in services, at what you actually paid including delivery.
• Direct labour at the real employment cost — salary plus employer taxes, holiday, sick cover and any benefits — not the hourly rate on the payslip.
• Your own time, at a rate you would have to pay someone to replace you. This is the most commonly omitted cost in small business.
• Equipment and tools consumed or depreciated on the job.
• Subcontractors, at the price you pay them, plus the cost of managing them.
• A share of overhead — premises, software, insurance, admin — allocated on a defensible basis such as labour hours.
• Wastage and rework at a realistic rate, taken from what actually happens rather than from what should.
• The cost of getting paid late, if your customers routinely do.

Allocate overhead or the margin is not what you think. Add up your annual overhead, divide by the productive hours you actually sell in a year — not the hours in the year — and you have an overhead rate per hour. Most small companies discover their sellable hours are far fewer than assumed, which raises the overhead rate and explains where the margin has been going.

Applying it

1. Calculate the fully loaded cost per unit or per hour, including the overhead allocation, using last year's real figures.
2. Decide the margin you need, working back from the profit the business must make rather than from a number that sounds normal.
3. Be clear whether you are applying a markup on cost or a margin on price — they are different, and confusing them is the most common arithmetic error in pricing.
4. Apply it consistently, and require a written reason for any job priced below it.
5. Track estimated cost against actual on every job for a few months. The gap is your real margin problem and it is usually in labour hours.
6. Feed those actuals back into the cost model quarterly.
7. Recalculate the overhead rate annually, and immediately whenever a large fixed cost changes.
8. Sense-check the output against the market — cost-plus can produce a price nobody will pay, and that is information about your cost base rather than about the market.

Markup and margin are not the same

A cost of 100 with a 25% markup gives a price of 125, on which the margin is 20%. A cost of 100 with a 25% margin gives a price of about 133. Businesses that intend margin and apply markup undercharge by exactly that difference on every job, which compounds quietly across a year. Decide which one your rule uses, write it down, and build it into the template so nobody has to remember.

The cost side of this lives in Ettex Books: a chart of accounts structured the way accountants expect, so overheads are grouped the way you would allocate them; categories and auto-categorisation rules so recurring costs land consistently; attachments on any entry so a supplier invoice stays with the transaction; multi-currency with rate tracking for imported materials; instant search across all periods; and P&L and ledger export as PDF, CSV or XLS to feed the model. The model itself — cost build-up, overhead rate, markup or margin — belongs in Ettex Sheets, and the resulting prices go out through Ettex Invoices with line items, quantities and rates.

The boundary: Ettex Books has no job costing. There is no per-project cost tracking, no time capture feeding into a job, no work-in-progress valuation and no margin report by customer or product. You build the cost model in a sheet from ledger exports. That is workable for a company quoting a few jobs a week; heavy job-costing needs software built around it.

Pricing from cost assumes the cost figure is right. Job costing software produces it per job — labour, materials, subcontractors and a stated overhead share — so the next quote rests on what the last similar job actually consumed.

Why cost-plus underprices

• Overhead left out entirely, so the margin silently pays for the office.
• The owner's time excluded, which makes small jobs look profitable when they are not.
• Labour costed at the payslip rate rather than the employment cost.
• Sellable hours overestimated when calculating the overhead rate.
• Markup applied where margin was intended.
• Wastage and rework assumed at zero.
• Estimated costs never compared with actuals, so the model never learns.
• The same margin applied to everything, ignoring that some work carries far more risk than other work.

Cost plus pricing is only as honest as the cost. Include overhead and your own time, use sellable hours for the rate, know whether you mean markup or margin — then compare estimates to actuals until the model stops surprising you.